Why The OPEC+ Deal Won’t Cut It

Now nearly a week removed from the OPEC+ agreement, confidence in the efficacy of the deal is becoming shaky.

Immediately after OPEC+ announced cuts of 1.2 million barrels per day (mb/d), a flurry of reports from oil analysts and investment banks congratulated the group on a job well done. After all, the 1.2 mb/d figure was larger than the market had anticipated.

However, reality is beginning to set in. First, the cuts might not be realized in January, despite the promise. Russia indicated that it was going to slow walk the cuts, phasing in an initial 50,000 to 60,000 bpd in reductions in January. This is significant because Russia is the main actor in the non-OPEC cohort. The non-OPEC group is expected to slash output by 400,000 bpd, but if Russia is only going to do its part gradually over the next few months, the non-OPEC cuts might not reach the promised levels anytime soon. Moreover, because there are no country-specific allotments, it will be hard to hold any producer accountable.

That undermines confidence in the deal. “Compared to early last week, the outcome was rather disappointing, the whole process wasn’t convincing, and it’s still uncertain whether they will actually cut,” ABN Amro senior energy economist Hans van Cleef told Bloomberg.

While oil traders are suddenly doubting the integrity of the deal, even if OPEC+ were to adhere to its promised cuts, it still might not be enough. That’s because there are other factors that could leave the market oversupplied. Cracks in the global economy are growing, demand is showing signs of strain, and supply continues to rise.

The EIA just issued its latest Short-Term Energy Outlook, and the agency still expects significant production growth from U.S. shale despite the downturn in prices. The EIA lowered its forecasted 2019 WTI prices by $10 per barrel from its previous report, yet it kept its supply forecast unchanged – it still thinks that U.S. oil production will rise from 10.9 mb/d in 2018 to 12.1 mb/d in 2019, despite the significant downward revision in prices.

In other words, U.S. shale production may not be slowed by the recent downturn in prices in any dramatic way, and at the same time, with its production cut agreement, OPEC+ reassured shale executives that it wouldn’t let prices fall any lower. “The US is not only the world’s largest oil producer at present, but will also remain the leading marginal producer in future,” Commerzbank said in a note.

According to Rystad Energy, OPEC+ would need to cut an additional 700,000 bpd in order to balance the market and bring Brent back up to $70 per barrel. “The OPEC+ agreement predictably came up short of what Rystad Energy argued would be required to fully balance the market in 2019,” Bjornar Tonhaugen, Rystad Energy head of oil market research, said in a statement. “The agreed production cuts will not be enough to ensure sustained and immediate recovery in oil prices. The muted market reaction seen thus far comes as no surprise to us.”

Rystad says that the cuts agreed to in Vienna provide a “soft floor” beneath oil prices for now, and the group can still succeed if it extends the cuts through the end of 2019. The OPEC+ coalition is set to evaluate the progress of the cuts in April and might decide to extend the cuts in June if they feel the market needs more time. “Most likely, OPEC will be forced to conduct production management sporadically over the next few years, unless US shale supply grows even faster than we currently expect. OPEC members have their work cut out for them in the years to come,” Rystad’s Tonhaugen said.

The supply surplus could still be eliminated by unplanned outages. Libya just lost 400,000 bpd because of encroaching militias, according to the National Oil Corp. Venezuela and Iran are also set to continue to lose output, while Nigeria remains a risk. These events are impossible to predict, and they could quickly erase any supply overhang.

For now, though, the oil market is not convinced that the OPEC+ cuts will be sufficient to significantly increase oil prices, despite the initial euphoria surrounding the Vienna agreement.